2021 looks to be different than 2020 in terms of hiring needs, company structuring, and management of resources and staff. Despite potentially major shifts, most private equity firms and venture capital fund managers still expect that the economy will improve this year—and they’re planning with that optimism in mind.
According to results of BDO’s Private Capital Pulse Survey, 74.5 percent of all fund managers surveyed expect the economy to improve in 2021. Of those, 28 percent expect it to be “much better” and 46.5 percent expect it to be “slightly better.” In Q4 2020, PE firms bounced back and finished on a high note, recording the highest quarterly deal value in over a decade, according to Pitchbook’s annual U.S. PE Breakdown.
PE Firms Pivoted to Distressed Companies in 2021
This sense of optimism doesn’t come without a dose of caution, of course. More than half (55 percent) of PE firms and VC fund managers said they’re preparing for a second wave of the COVID-19 pandemic by conducting business continuity risk assessments, and many others are taking similarly cautious measures. In addition, many PE firms and hedge fund managers are focusing less on new deals this year, and instead are turning their focus to companies that need a lifeline amid fallout from the pandemic.
CPA Practice Advisor’s analysts say they expect to see distressed deal activity pick up in 2021, as businesses that are still experiencing disruption deplete their coronavirus federal relief loans. According to the BDO survey, 46.5 percent of fund managers believe that investing in distressed businesses will be a key driver of deal flow in 2021, versus 40 percent who said the same a year ago. And a poll commissioned by fund service firm Intertrust Group found that 92 percent of private equity professionals across North America, Europe, and Asia believe that distressed fund activity will increase as a result of the coronavirus pandemic. In fact, PE managers said they viewed distressed funds as the biggest fundraising opportunity in the near future, with 83 percent indicating that there would be more investor demand for strategies that involve distressed assets.
BCG analysis shows that more than half of U.S. companies are under operational or financial stress and 14 percent are in distress. Warning signs of distress may include more traditional KPIs, as well as more-subtle red flags. As more PE firms are shifting their focus to distressed portfolio companies, it’s important to keep in mind that a positive relationship between the PE firm and the portfolio company’s management team is key to the success of both the company and the firm. A troubled relationship may lead to drastic measures that solve near-term liquidity problems but hurt the company in the long term. By taking steps to make the relationship between the two parties a healthy and positive one, PE firms and management teams can turn around a distressed situation and build—or rebuild—a sustainable business that will continue long after the PE firm exits.
Making Necessary Choices Now for a Company’s Long-Term Success
Achieving this harmony, however, isn’t always easy. This is particularly true when some members of the portfolio company’s leadership are resistant to making the changes necessary to turn around the business. As Greg Schooley, value creation leader at Ernst & Young LLP, says, “Often a management team really knows why their business is faltering but they are afraid to face the core issues, especially with their PE investors. Getting them to accept and openly address the issues without feeling blame is critical.”
Ideally, you will be able to successfully work with the management team to take necessary steps on the path to viability through your turnaround plan. If, based on KPIs and adherence to the plan, performance still isn’t turning around, you must then ask: “Do we still have the right team in place to execute on the challenges in front of us?”
While the PE firm should explore a number of strategies to achieve honest communication and acceptance of what’s needed, the toughest decision—making changes in a company’s management team—is sometimes the right one. It may be the only way to get a company unstuck and help them help themselves, before the distress is too severe and it’s too late to turn things around. Waiting too long while trying other approaches may in fact cause permanent damage, making a financial comeback out of reach. Timing is everything, and the goal is not to simply help the business survive, but ultimately thrive, so early intervention is key. Though the pandemic may have been the main cause of the distressed situation, a transformation can help the company reach its full potential by fixing outlying issues that should have been addressed long before.
Getting the Right People in Place to Make Big Changes
Making the difficult decision to replace a member of the management team with an interim or permanent executive often isn’t about incompetence. Rather, it’s about putting people in place who are aligned with the changes that need to be made; who possess skills that may not exist on the current team (but are needed for a period of transformation); and who can bear the burdens of being unpopular for the decisions they may make on behalf of the organization. Though it’s sometimes a last resort, it might also be the only way to make an immediate and significant impact at an organization that’s stuck.
Here are four ways a change in the C-Suite can create positive opportunities for a distressed portfolio company:
Spearhead needed change and innovation. Deeply held mindsets or beliefs of one or a few people can hold an entire management team back. Leaders who have been in their positions for a long time are likely mired in legacy or homegrown processes, or comfortable with complicated ways of doing things that have set the company back—and that are continuing to do so. Even though they know the “old ways” aren’t doing them any favors, they may be resistant to try new ways of doing things out of fear of the unknown.
On the other hand, a new CEO, CFO, or other C-suite executive may be more willing to experiment with new strategies that his or her predecessor was not, and these strategies may be instrumental in turning the business around. It’s important to note that this trailblazer must also be willing to work well with and learn from existing team members: they’ll need one another to be successful. The institutional knowledge that exists within longstanding members of management is vital as the team moves forward and navigates new changes—coordination and cooperation are key.
Bring a fresh perspective and skill set. Someone new to an organization often has the advantage of seeing things through a wide-angle lens and spotting errors or opportunities for improvements right away that may have been difficult for veteran team members to see. Without the burden of knowing all the company’s complicated history, this new executive may also be able to see problems—and their solutions—in a simplified way.
It’s also important to ensure that you have the right skill sets in place for what is often an unprecedented transformation for the company. This may be an opportunity to find hidden talent within the organization, as well as bring in fresh faces with the skills to deal head on with challenges and change . After all, the skills that are necessary to lead a company through a period of transition are often very different from those skills needed to run a company in “normal” times. As Michael Epstein, global managing principal for restructuring services at Deloitte, says, “The person whose job it is to keep the train on the tracks does not often have the same skills to get the train back on the tracks.”
Be agile and make tough decisions. When change is stagnant, it’s often because group-think, peer pressure, or emotions get in the way and block needed progress. Someone new has the advantage of being separated from longstanding company politics and relationships, giving them the freedom to be agile and do what’s best for the future of the company—even if it means abandoning old business models or making the difficult call to reduce the size of the workforce. In times that call for bold action and decisiveness, you need someone who has the fortitude and grace to stand up and make the kinds of necessary choices that a more seasoned employee of the company may be hesitant to do.
Align the organization’s vision. While tough decisions will need to be made, it’s also important that you have a leader in place with the ability to bring everyone together to embrace and support the company’s new mission—and in a largely virtual workplace environment, to boot. This person will need to change mindsets, create a shared sense of purpose, gain employees’ trust, and be a whip-smart communicator. They also need to ensure that employees at all levels feel psychologically safe in a time of flux. Tall order? Perhaps—but it’s an essential role and, thankfully, many interim and permanent executives actually specialize in leading during times of organizational change.
By proceeding with a measured and thoughtful approach, bringing on new management personnel can energize the entire organization, with minimal disruption in light of its expansive long-term, positive impact. After all, successful organizations don’t change—their people do.